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MACROECONOMIC AND
MONETARY DEVELOPMENTS
IN 2009-10
Overview
Global Economic Conditions
1. Recovery in the global economy picked
up momentum in the fourth quarter of 2009.
The speed of recovery, however, remains
significantly divergent. The projections for
global output for 2010 generally point to
consolidating recovery, led by the Emerging
Market Economies (EMEs). The WTO
projects world trade to stage a strongrecovery in 2010. The risks to the overall
global macroeconomic environment have,
however, increased because of large public
debt in advanced economies, on the back
of concerns relating to reduction in
potential output, high unemployment rates,
impaired financial systems and premature
exit from the policy stimulus. Closer home,
the improvement in global macroeconomic
conditions is reflected in the turnaround in
Indias exports and the return of capital flows. With stronger recovery in EMEs
driven largely by domestic demand,
improving exports and return of capital
flows, EMEs face the risks of inflation and
asset price build up.
Output
2. Concerns about domest ic output
growth are now subdued as the recovery is
getting more broad-based. This is the result
of a rebound in industrial output, betterprospects for the Rabi crop and continuing
resilience of the services sector. Survey data
suggest increasing levels of capacity
utilisation in recent months. Subject to
normal monsoons, output growth during
2010-11 is expected to gain further
momentum.
Aggregate Demand
3. Final consumption expendi ture
remained subdued during 2009-10, as
growth in both private final consumption
expenditure and government final
consumption expenditure decelerated.
Investment demand, particularly gross
fixed capital formation, however, showed
a gradual recovery during the year. While
the momentum in investment demand is
expected to continue, pick-up in private
consumption demand could drive the
recovery in growth. The fiscal exit, as
planned in the Union Budget for 2010-11,
would contribute to improving the overallmedium-term growth outlook, even as
going forward, greater emphasis on quality
of fiscal adjustment would be necessary.
External Sector Developments
4. Indias external sector posit ion
improved alongside the recovery in the
global economy. After declining for 12
consecutive months, exports recovered in
October 2009. Similarly, imports recovered
in November 2009 following a phase ofdecline. Despite a lower trade deficit, the
current account deficit widened during
AprilDecember 2009, as compared with
i
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Macroeconomic and Monetary Developments in 2009-10
the corresponding period of the previous
year. This is attributable to a fall in invisibles,
particularly on account of business
services. During 2009-10, foreign exchangereserves increased by US$ 27.1 billion,
comprising mainly of increase in gold
holdings (US$ 8.4 billion), SDRs (US$ 5.0
billion) and foreign currency assets (US$
13.3 billion). The bulk of the increase in
foreign currency assets was on account of
valuation. Net capital inflows can be
expected to increase further during the
current year, reflecting the prospects of
higher growth and larger interest rate
di fferentials between India and theadvanced economies. Like other EMEs,
however, higher capital inflows could
influence asset prices, domestic liquidity
conditions and the exchange rate. This will
have implications for monetary management.
Monetary and Credit Conditions
5. Reflecting the stronger recovery in
economic activities, growth in broad money
(M3) and flow of credit to the private sector
exceeded the Reserve Banks indicativeprojections for 2009-10. While the increase
in CRR effected by the Reserve Bank in its
Third Quarter Policy Review of January
2010 led to some moderation in excess
liquidity, overall liquidity conditions
remain comfortable as reflected in the daily
reverse repo operations. The banking
systems credit to the Government was the
prime driver of monetary expansion during
the year. The flow of resources to
commercial sector distinctly improved from
both bank as well as non-bank sources.Going forward, the demand for money may
increase with acceleration in recovery and
the elevated level of inflation.
Global Financial Markets
6. Global financial markets exhibited
significant stabilisation during 2009,despite the drag from the global financial
crisis. However, volatility increased in the
beginning of 2010 due to concerns about
unsustainable fiscal positions, as reflected
in sovereign risks. Episodes such as the
Dubai World debt standstill and the
sovereign debt problems in Greece and
East European countries pose a major risk
to the stability of financial markets going
forward.
Domestic Financial Markets
7. With market activity returning to the
pre-global crisis level, volatility in the
domestic financial markets was much lower
during 2009-10 than in the year before, when
the crisis erupted. Despite considerable
stability and the commencement of exit,
markets faced concerns emerging from
large government borrowings and the
increase in inflation. This affected yields in
the government bond market. The
transmission of lower policy rates to thecredit markets improved, albeit, slowly. Asset
prices increased at a relatively faster pace
in the recent months. With the revival of
capital inflows, nominal exchange rate
appreciated. Given higher domestic
inflation, the appreciation in real terms was
even higher.
Inflation Situation
8. Headline WPI inflation firmed up
significantly during the fourth quarter of2009-10. The initial inflationary pressure
was predominantly conditioned by rising
food and fuel prices, reflecting the impact
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Overview
iii
of a deficient monsoon on agricultural
output and the increase in international
crude prices. In the second half of the year,
with persistent supply side pressures,inflation became increasingly generalised.
This is evident from the acceleration of
inflation in non-food manufactured
products from -0.4 per cent in November
2009 to 4.7 per cent in March 2010.
Inflation, as measured by consumer price
indices (CPIs) also remained high, though
there was some moderation in February
2010. These inflationary conditions,
coupled with the stronger momentum seen
in the pace of economic recovery, createdthe compelling ground for altering the
Reserve Banks balance of policy focus to
anchoring inflation expectations.
Growth Outlook
9. Output growth in 2010-11 is expected
to be higher than in 2009-10, assuming a
normal monsoon. Support for sustained
momentum in growth can be expected from
all three major components, viz.,
agriculture, industry and services.Nevertheless, apart from monsoon-related
uncertainty, other downside risks to growth
need to be recognised. First, private
consumption demand needs to improve
significantly to support the growth
momentum. Second, global recovery,
despite gaining strength, is expected to
remain fragile, which has implications for
exports. Third, the exit from fiscal stimulus
and the growth-supportive monetary policy,
unless calibrated carefully, could impact
the growth process. Finally, the domestic
saving rate has exhibited some decline, led
by significant decline in public sector
savings. This has adverse implications for
the potential growth of the economy.
Inflation Outlook
10. Inflation can be expected to moderate
over the next few months, from the peak
levels seen in recent months. There are,
however, upside risks to inflation. First,
international commodity prices, particularly
oil, have started to increase again. In several
commodities, the import option for India to
contain domestic inflation is limited, because
of higher international prices. Second, the
revival in private consumption demand and
the bridging of the output gap will add to
inflationary pressures. Finally, it is important
to guard against the risk of hardening of
inflation expectations conditioned by near
double digit headline WPI inflation.
Overall Assessment
11. With the improving growth outlook,
monetary and fiscal exit measures havestarted. While recovery in private demand
needs to be stronger to reinforce the growth
momentum, the already elevated headline
inflation suggests that the weight of policy
balance may have to shift to containing
inflation, since high inflation itself will
dampen recovery in growth. In the emerging
macroeconomic scenario, monetary policy
management in 2010-11 will be dominated
by the challenge of moderating inflation and
anchoring inflation expectations, while
remaining supportive of growth impulses.
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